We hear a lot about governance and metagovernance in web3 and Ethereum-based DAOs; rightfully so as it is the primary utility of the ERC-20 tokens we use to make high-level decisions (e.g. - elections, protocol upgrades, liquidity provisioning, resource allocation).
Below are some thoughts on the interrelationship of governance, tokenomics, and value.
Governance Token Accumulation Motivations
While most parties accumulate tokens with the expectation of greater future value, some accumulate for the purpose of governing the actions of an organization; I’ll make the distinction here of Value Participation and Governance Participation respectively.
Value Participation - Accumulating tokens primarily for the purpose of extracting greater value in the future.
Governance Participation - Accumulating tokens primarily for the purpose of exerting influence within the organization.
Some actors participate for both reasons; however, value participation is typically not valuable to the organization (unless it drives another outcome via tokenomic methods, see below) and governance participation is only valuable if provided by high-context actors.
Organizational Needs
In a value sense, an organization needs the value it creates to be captured by the system creating it (DAO revenue accumulated to a treasury). In a governance sense, the organization needs that value allocated toward the shared goals of the DAO members.
- What are the shared goals of the DAO?
- What is the best allocation of resources to achieve the established shared goals?
- Can ongoing resource allocation be predicted and automated to drive desired economic activity?
Delegation
Delegation is the renting out of governance participation, but not value participation. In effect, think of a delegator as a landlord: you get the utility (governance participation), they retain value participation. Why would a delegator lend votes? Because they expect a greater return than if they didn’t (having good governors exerting influence is the method that the value participant deems most valuable). Protocols such as Paladin (vote lending market) are betting that a P2P market for vote lending is the optimal implementation of this practice.
Value-Only Participants
At the extreme we have value-only participants that either don’t know about or care about the governing aspects of the token for the timeframe that they plan to participate. This includes whales and arbitrageurs that might hold a token for years or one block with the intention of extracting greater future value. Value-only participants do not add any value to the organization.
The Ideal Governance Participant
Ideally governance participants are high-context, able to positively influence the economic return of the organization, and incentivized to do so.
The Importance of Tokenomics in Governance
The role of governance in an organization is to provide organizational direction via individual participation. The role of tokenomics in governance is to ensure that the right proportion of decision-power is in the right place for the organization to sustain and thrive through selection of the best options, and that comes down to three categories of participant:
- Proposer
- Decider
- Executor
In most DAOs, anyone can propose (or this is gated somehow) and the DAO executes on the decision (not always, but generally). In a social DAO, these three parties might be one in the same. In a product DAO they might be completely divorced. No matter, the role of tokenmics is to align parties in coordinated action.
Ideally a tokenomic model incentivizes the valuable economic activities of the organization while ensuring that high-context deciders are always positioned to govern the organization. An example:
Index Coop is a product DAO that builds and launches on-chain indexing products. The most impactful decision the DAO makes (in terms of how contributors spend their time and economic success of the organization) is what product to launch next. The greatest economic need of the DAO to support products is AMM liquidity for those products. A good tokonomic model would continually redistribute value to those that provide liquidity and governance to those that make good product-launch decisions.
Tokenomics mainly deals with the utility and distribution of governance tokens, as incentive.
Tokenomics: Utility
Tokenomic utility deals with what can be done with a token, and how much that is valued. Utility in this sense is not limited to one use-case. A token may provide voting rights and gated access to a server; both are useful and are valued differently by participants. In some cases a governance token confers voting rights in a specific way (directing liquidity by staking); this is still utility, however the value received in yield terms isn’t the utility, it is a tokenomic benefit of exercising the utility.
Tokenomics: Distribution
Genesis Distribution
The genesis distribution is typically the method of bringing economically aligned actors together. Those with varying resources and aligned motivations can be incentivized to coordinate for greater communal benefit (expected group-benefit is greater than expected individual-benefit AND greater expected group-benefit than from other groups). If the model for working together or the underlying technology are novel we often see emergent value instantly upon a genesis token distribution (e.g. Uniswap, Ethereum Name Service).
Ongoing Distribution
Ongoing token distribution is a feature of blockchain/token-based governance that provides the greatest promise relative to non-blockchain fractional/shared-governance models. Power and influence tend to accumulate in models without ongoing redistribution, or companies with traditional shareholder models. A tokenomic model can incentivize greater economic output through continuing to redistribute both governance to those that are the best wielding it, and value-creation to those that are providing economic value to the organization.
Tokenomics: Aligned Economic Activity
An organization has needs and generates output (much like an organism). Just like billions of braincells come together to sustain a human, a group of deciders come together to determine how to sustain an organization. In essence the deciders determine what there is to work with, where they want to be, and how to get there - or more simply, what internal and external activities accumulate the greatest economic value to the organization. Tokenomic planning requires taking account of needs and matching outputs effectively for maximum economic benefit. Effectively, using incentives and coded agreement to coordinate aligned economic activity is the novel unlock of a permissionless public blockchain.
Conclusion
Governance of an organization using fractionalized voting rights is not novel; programmatically redistributing voting rights is new. Tokenomic distribution is the foundation of a token-based governance model. A failure to tokenomically redistribute governance to those with highest context will likely result in governance capture (accumulation by one or few parties), governance failure (bad outcomes leading to value destruction), or misalignment (refusal to willingly execute). A great exploration of possible governance failures at Index Coop is explored here for further reading.